Curtailing Multistate Tax Filing Burdens

Several members of the House of Representatives, led by have introduced the Mobile Workforce State Income Tax Fairness and Simplification Act, H.R. 2110, intended to "limit the authority of States to tax certain income of employees for employment duties performed in other States." Essentially, the legislation would prohibit a state from taxing the wages of nonresident employees who perform services in the state for fewer than 31 days, and would relieve their employers from any obligation to withhold income taxes on behalf of a state in which an employee performed services for fewer than 31 days unless the employee was a resident of the state.

The text of the bill is worth reading:

Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled,

SECTION 1. SHORT TITLE.
This Act may be cited as the ‘Mobile Workforce State Income Tax Fairness and Simplification Act’.

SEC. 2. LIMITATIONS ON STATE WITHHOLDING AND TAXATION OF EMPLOYEE INCOME.

(a) In General- No part of the wages or other remuneration earned by an employee who performs employment duties in more than one State shall be subject to income tax in any State other than-- 1) the State of the employee’s residence; and

(2) the State within which the employee is present and performing employment duties for more than 30 days during the calendar year in which the income is earned. >

(b) Wages or Other Remuneration- Wages or other remuneration earned in any calendar year are not subject to State income tax withholding and reporting unless the employee is subject to income tax under subsection (a). Income tax withholding and reporting under subsection (a)(2) shall apply to wages or other remuneration earned as of the commencement date of duties in the State during the calendar year.

(c) Operating Rules- For purposes of determining an employer’s State income tax withholding and information return obligations--

(1) an employer may rely on an employee’s determination of the time expected to be spent by such employee in the States in which the employee will perform duties absent--

(A) actual knowledge of fraud by the employee in making the estimate; or

(B) collusion between the employer and the employee to evade tax;

(2) if records are maintained by an employer recording the location of an employee for other business purposes, such records shall not preclude an employer’s ability to rely on an employee’s determination as set forth in paragraph (1); and

(3) notwithstanding paragraph (2), if an employer, at its sole discretion, maintains a time and attendance system which tracks where the employee performs duties on a daily basis, data from the time and attendance system shall be used instead of the employee’s determination as set forth in paragraph (1).

(d) Definitions and Special Rules- For purposes of this Act:

(1) DAY-

(A) An employee will be considered present and performing employment duties within a State for a day if the employee performs the preponderance of the employee’s employment duties within such State for such day.

(B) Notwithstanding subsection (d)(1)(A), if an employee performs material employment duties in a resident state and one nonresident state during one day, such employee will be considered to have performed the preponderance of the employee’s employment duties in the nonresident state for such day.

(C) For purposes of subsection (d)(1), the portion of the day the employee is in transit shall not apply in determining the location of an employee’s performance of employment duties.

(2) EMPLOYEE- The term ‘employee’ shall be defined by the State in which the duties are performed, except that the term ‘employee’ shall not include a professional athlete, professional entertainer, or certain public figures.

(3) PROFESSIONAL ATHLETE- The term ‘professional athlete’ means a person who performs services in a professional athletic event, provided that the wages or other remuneration are paid to such person for performing services in his or her capacity as a professional athlete.

(4) PROFESSIONAL ENTERTAINER- The term ‘professional entertainer’ means a person who performs services in the professional performing arts for wages or other remuneration on a per-event basis, provided that the wages or other remuneration are paid to such person for performing services in his or her capacity as a professional entertainer.

(5) CERTAIN PUBLIC FIGURES- The term ‘certain public figures’ means persons of prominence who perform services for wages or other remuneration on a per-event basis, provided that the wages or other remuneration are paid to such person for services provided at a discrete event in the form of a speech, similar presentation or personal appearance.

(6) EMPLOYER- The term ‘employer’ has the meaning given such term in section 3401(d) of the Internal Revenue Code of 1986 (26 U.S.C. 3401(d)) or shall be defined by the State in which the duties are performed.

(7) STATE- The term ‘State’ means each of the several States of the United States.

(8) TIME AND ATTENDANCE SYSTEM- The term ‘time and attendance system’ means a system where the employee is required on a contemporaneous basis to record his work location for every day worked outside of the state in which the employee’s duties are primarily preformed and the employer uses this data to allocate the employee’s wages between all taxing jurisdictions in which the employee performs duties.

(9) WAGES OR OTHER REMUNERATION- The term ‘wages or other remuneration’ shall be defined by the State in which the employment duties are performed.

SEC. 3. EFFECTIVE DATE.
This Act shall be effective on January 1, 2011.

The bill focuses on a problem that afflicts many business entreprises. An employee who lives and works in the state in which the employer operates performs services in another state for part of a day, a day, or several days. Many states require the employer to withhold income taxes on the portion of the employee's compensation apportioned to the state, and even if withholding is not required, many states require the employee to file a nonresident income tax return with the state. If an employee performs services for a few days in, say, a dozen states, the employee ends up being required to file a dozen state income tax returns. This can be burdensome, not only in terms of quantity, but in terms of working out things such as the credit for taxes paid to other states. It can create a complexity to rival that posed by the federal income tax law.

The bill appears to resolve another thorny area of state income taxation. Some states take the position that a person who is not physically present in the state, and who therefore can be taxed as though they are present only if they have sufficient nexus with the state, has that nexus if he or she is virtually present in the state by virtue of telecommuting. I explained this issue when I described the travails of Thomas Huckaby, a Tennessee resident, who, though spending only 25% of his time at the New York offices of his employer, discovered that New York required him to pay New York income tax on all of his compensation. The story of his case, and of a Connecticut resident who did not have any physical presence in New York, are recounted in a series of MauledAgain postings: State Taxation of Nonresidents, Another Setback for the Telecommuting Nonresident Taxpayer, New York Takes a Strike in the Tele-commuter Tax Game, Supreme Court Refuses to Resolve Interstate Tax Dispute, If the Supremes Won't Sing for the Taxed Telecommuters, Will the Congress Dance? It seems that the Congress will dance for Huckaby only if he limits his presence in New York to fewer than 31 days.

The language of the bill does suggest several questions. In no particular order, here they are:

1. Why, in section 2(c)(2), permit an employee's determination to trump records maintained by an employer that record the employee's location for other business purposes? If the employee is in State X, the employee is in State X. Considering that section 2(c)(3) requires an employer's time and attendance system to trump the employee's determination, it makes no sense to treat any other set of records keeping track of the employee's location any differently.

2. Why use a preponderance standard in section (d)(1)(A)? Would it not make more sense to provide more specific rules that deal with instances in which, for example, an employee resident of State T, performs, on a particular day, 3 hours of work in State X, 2 hours in State Y, and 2 hours in State Z? Would the employee be treated as having performed work in none of the three states?

3. Has consideration been given to the imprecise meaning of the term "material employment duties"? Would it not make more sense to use a test identical to, or similar to, the preponderance test? It's one thing to measure hours, and it's a totally different, and much more challenging, task to measure the materiality of employment duties.

4. Why is there no relief for independent contractors? Do they not face similar issues in terms of both tax return filing and the equivalent of withholding obligations, namely, estimate tax payment requirements?

5. Though it is obvious why professional athletes and professional entertainers are excluded from the definition of employee, does it make sense to define the exception in this manner? If the proposed legislation applied to professional athletes and entertainers, the wages paid to most of them would not be subject to taxation by the states in which they perform services because they usually are in those states for fewer than 31 days. Even so, under current law, states collect substantial amounts of revenue by taxing nonresident professional athletes and entertainers who work even for one day in the state. In the absence of the exclusion, state opposition to the proposed legislation would be even more intense and vociferous. But does it make sense to permit states to continue taxing nonresident professional athletes and entertainers whose income is relatively small, considering the transaction cost to those individuals of complying with the income tax laws of dozens of states and filing tax returns with dozens of states? Does this make sense considering the application of the proposed legislation to high-income individuals who are not professional athletes or entertainers but who work for a few days each year in many different states? Would it not make more sense to tie the exclusion from the bill's protection to total income, so that professional minor league ballplayers earning survival wages are relieved of dealing with multistate income tax return filing, while high-income attorneys, architects, and other professionals who work for five or six days in each of fifteen states are treated in the same manner as high-income athletes or entertainers who perform for five or six days in each of fifteen states? In other words, why single out individuals on the basis of the name of their occupation rather than their income?

6. How many times will the phrase "persons of prominence" be litigated? Does it matter that everyone is famous for at least 20 minutes? Is the CEO of a corporation, whose name is known only to family, friends, and some business associates a person of prominence? Should this person be relieved of multistate income tax return filing if he or she works for a few days in each of the twenty-two states in which the company has offices? Again, ought not the exclusion, if there is to be one, rest on income and not difficult-to-define occupational labels?

Despite these criticisms, there is some sense in what the bill attempts to do. Individuals with low or even moderate income, whether employed or self-employed, who work for a few days in a particular state, ought not be burdened with the high transaction costs of filing an income tax return that generates relatively few dollars of revenue for the state. Lest the state see this as a revenue loss, consider that the state's own residents will be similarly relieved of paying taxes to other states, in turn cutting down on the credit for income taxes paid to other states that they would otherwise claim. In other words, though there may be some shifting of state income tax revenue from states with proportionately higher numbers of nonresident workers to states with proportionately lower numbers of nonresident workers, for most states the change will be negligible.

Whether Congress actually does something with the proposed legislation remains to be seen. What is unlikely is passage of the bill in its current form. That's not a problem. The introduction of the legislation ought to trigger conversations and analyses, which in turn should lead to refinements and improvements.

The (Non) Value of Old Exams

The exam period begins today at the law school. Anxiety and stress, particularly among first-year students but also among the more seasoned upper-year students, is rampant. One of the "exam preparation" techniques most favored by students is to get their hands on a previous semester's exam in the same course with the same professor. Somehow, students think, by looking at the old exam they will have a better chance of doing well on their upcoming exam. Unless the exam comes with a model answer, an description of erroneous answers and why they don't earn credit, and an explanation of how to think through the facts of the question to get to the correct answer or answers, the old exam is of little value. Surely a student looking at an old exam and thinking to himself or herself, "Oh, yeah, I know the answer to this one" gathers as much positive reinforcement as I do when I look at a basketball hoop and think, "Oh, yeah, I can dunk the ball." Of course, some students will then bring the old exam to the professor and ask for the answers. At this stage students ought to be trying to answer the question to see if they can do so, and at best should be bringing to the professor the answer that the student has already worked out.

It's clear why students want to dig out old exams. For whatever reason, many law students continue to approach legal problems with the notion that there is a finite set of possible questions, and if they can find all of them in a setting that provides the answers to all of them, when they get to the exam that counts, they can dial up whichever one matches the question on the exam. The flaw in this reasoning, of course, is the idea that there are a finite set of possible questions. I know that students do this, because they tell me that they do this. Not long ago, a student approached me about a semester exercise -- think of a short-answer question extracted from what otherwise would be an exam and presented to the students as a stand-alone graded assignment -- with the concern that he had looked everywhere and could not find an example (facts and solution) that matched the assignment. Of course he wouldn't find it, and he was wasting his time looking for it. I explained that he needed to identify the issues for each of the four very short question within the exercise, and then apply the process for resolving that issue. The process could be in the form of a checklist, a chart, a Harvard outline, a Venn diagram, whatever. Eventually he returned, and was delighted that he had figured it out. On many occasions, when I get the point across to a student that the key is the process and not the information, the reaction is along the lines of "I wish I had figured this out during my first year." So do I. But that's another topic, a highly sensitive one, and I will leave to another day the question of why students come into upper-year courses, or even get through law school and into an LL.M. Program, without having grasped the "secret" to thinking -- no, not thinking like a lawyer, but simply thinking -- that is the key to doing well not only in law but in numerous other professions, trades, and activities.

The analogy I use is the solving of crossword puzzles. What many students try to do when learning law is to acquire a set of all possible crossword puzzles and their solutions, so that when they encounter a puzzle, the solution is at hand. The flaw in this approach is the fact that there are an infinite number of crossword puzzles. There is no way one can have an inventory of all possible crossword puzzle solutions. Instead, the secret to solving a crossword puzzle is to have a methodical process of working through the puzzle, analyzing each factor that is relevant, such as the number of letters, letters already in place from having worked out another clue, possible letters already in place from having identified tentative resolutions of other clues, understanding the theme of the puzzle if there is one, etc. I wrote about this issue five years ago in Doing Puzzles While Learning & Practicing Law, which appeared in the law school's weekly newsletter. I wrote this essay not only to explain to law students why the thinking involved in solving puzzles is almost identical to the thinking required to solve legal problems, but also to encourage students to question whether their alleged dislike for doing puzzles meshed well with their expressed interest in pursuing a career of solving problems. The flip side, preventing problems, is more similar to creating crossword puzzles, which is, as anyone who has tried to do so understands, far more challenging than solving one. I have come to understand the comments made to me by more than a few of my law school faculty who later became my colleagues to the effect that preparing and designing an exam is far more challenging than taking one. I plan to write about that particular challenge at some later date.

In my tax courses, there is yet another reason to discourage students from digging into old examinations. Tax law changes so frequently that what was a good question on last year's examination may have become obsolete. Or perhaps the answer has changed. Or perhaps the choices are no longer valid, either as correct answers or as plausible erroneous answers. Or perhaps the issue has gone from one that is easily resolved using general principles to one that must be wrung through a maze of new statutory or regulatory provisions, such that without additional or different facts, the question is close to useless. Or perhaps the question addresses a topic no longer covered in the course because it became too complex, or needed to be removed in the on-going triage of finding space for the new "tax goodies" bestowed on tax students by the Congress. Going through an old exam, explaining why a question is obsolete, or explaining why the choices are misleading, ends up confusing the student by filling his or her head with more information, information which is extraneous to the scope of the course and of little or no interest to students not headed for tax careers.

For these reasons, I do not publish old examinations. I don't want to enable the sort of thinking that causes students to hunt for old examinations, or even to dig through the old examination database that the school maintains. I don't want to waste students' time or mine going through an exam that is obsolete in part, misleading in part in light of intervening changes, or that covers topics no longer covered in the course. I don't want to take students away from what they should be doing.

Instead of digging through old exams in search of the "magic key" to the kingdom of legal studies, students ought to be assimilating the material that they have covered during the semester. In fact, they should be doing this throughout the semester and not in one end-of-semester flurry of catch-up-and-cram insanity that includes the rush for the "quick and easy" solution, and that results in acquisition of knowledge that vanishes from their brains hours after the examination, unavailable for recall in the next course or while representing the next client. Throughout the semester and at the end, students ought to be reviewing the problems that were analyzed in class. They should be creating, or, better, refining their own checklists, flowcharts, matrices, outlines, Venn diagrams, whatever. They should be teaching each other in study groups. They should be taking the various problems and hypothetical questions from class and running through the many possible permutations on those problems and questions. They should be going to CALI and working through the hundreds of questions that do, in fact, give them a chance to test themselves, and, within moments, to find out if they understand what they need to understand to do well on an examination.

By requiring students to turn in responses to assignments during the semester, I get the opportunity to identify students who approach problems by trying to regurgitate law, or by answering something that hasn't been asked, or by misreading the facts, or by making one or another of the very common errors law students make on examinations and, if uncorrected, when representing clients. I'd rather that a student lose 2, 4, 8 points on an exercise than commit the same mistake repeatedly on an examination and lose 40, 60, or 80 points with no chance to engage in ameliorative endeavors. This process encourages students to do what they should be doing early enough that the product of their efforts sticks in their brains for a much longer time, provides them with the opportunity for positive reinforcement when they are on track, and gives them the chance to identify flaws in their approach to problems long before grades are released months after the course is finished.

If law required only the identification of all possible situations, each with a correlative answer, computers could replace lawyers. Some people, in jest or not, might find this to be an improvement in life and for society. Yet computers cannot replace lawyers, at least not for many decades, because the contribution of lawyers to society is not only in the application of settled rules to the ordinary transactions of some clients, but to the development of answers to the problems that arise for the first time. A lawyer does not work through the case of first impression by looking up an answer or by having memorized some rules. A lawyer works out the problem by using a process of thinking. Once a student understands this "secret," the possibilities, as a student once told me, are staggering. Indeed, they are.

The Collapsing Economy: A Clue and Some Advice

Last Tuesday, the Hearing Board of the Illinois Attorney Registration and Disciplinary Commission (IARDC) issued a report and recommendation for the three-year suspension from the practice of law of an attorney who, over a period of years, answered law school application questions by omitting the fact he had attended medical school and the fact he had been dismissed for academic reasons, provided to prospective employers law school transcripts which he had altered to show markedly higher grades than the ones he had earned, and failed to disclose to the Illinois State Bar's Character and Fitness Committee his fraudulent alteration of transcripts. Though there is much that can be said about this unfortunate series of events, most of it has already been shared, notably by commentators at the ABA Journal, the American Law Daily, the American Lawyer, and the Legal Profession Blog. Thanks to Paul Caron's TaxProf Blog for bringing this update in the story to my attention.

Some of the reports included, without much comment, a reference to one of the tangential facts of the case. In its report, the Hearing Board of the IARDC explained that the attorney in question "is currently pursuing an MBA at the University of Illinois Business College." In his application to that school, he "did not mention the falsified transcripts, the problem with the law school paper, or the omission on the law school application, but he did not believe that information was responsive to any question on the application. He did disclose his dismissal from medical school." The problem with a law school paper refers to an investigation with respect to a suspicion of plagiarism that did not lead to formal charges by the school. The attorney reported that he contacted the assistant dean of student affairs at the University of Illinois Business College before he began the program, to explain the complaint pending before the IARDC, "disclosed the general nature of the allegations, and offered to provide a copy of the complaint, but his offer was declined because the school was only interested in matters of a criminal nature."

If indeed the University of Illinois Business College is interested only in "matters of a criminal nature" when screening applicants, and if that is the general practice among business schools, is it any wonder that a critical mass of business school applicants who have issues with respect to integrity and disclosure are getting into those schools, graduating from those schools, entering the business world, and ending up in positions where the lack of integrity and disclosure causes long-term and serious damage to people, enterprises, industry, and the economy? Ought not business schools, and, in fact, all schools, identify applicants who are in need of integrity counseling, and either refuse admission or make admission and graduation contingent on the student straightening out his or her life? Are not business schools responsible for preparing people to function in the business world, and is not one of the requirements for doing so not only an understanding of what integrity and disclosure require but also a demonstration that a person possesses a character marked by those traits? If schools are unable to "teach integrity," then they ought not admit someone into their programs who lacks that attribute.

Whether, and to what extent, schools need to investigate the background of their applicants are debatable questions. Surely, though, it costs little and perhaps nothing to add to the application questions that reach beyond "only … matters of a criminal nature." Does it hurt to ask applicants if they have ever altered transcripts, submitted fraudulent resumes, plagiarized papers, or violated the Academic Rules or Honor Code of any institution in which they previousl were enrolled? Considering the high rate at which people confess, anonymously in surveys, that they submit false resumes, is it any wonder that people willing to lie to get a job would be willing to commit fraud in order to make money marketing or selling whatever it is they're foisting on an unsuspecting public, be it tainted securitized mortgage loan packages, defective products, shoddy services, or some other junk? Is there not an obligation among business and other schools to require applicants and students to have and follow principles of integrity so that the nation's culture squeezes out practices like these, practices apparently so widespread that the litany of resume fraud committed by specific individuals shared by that particular site is a drop in the bucket of the dishonesty pervasive in "modern" American business culture? The "everybody does it" nonsense hyped by this site is nothing more than an excuse for people unwilling to take responsibility for doing what is right. The attorney who was the subject of the report and recommendation of the IARDC Hearing Board admitted that he did what he did in part because he "wanted to portray an image of being successful" and "felt that he needed to work at a premier law firm to confirm that he was successful." In other words, he went for the appearance rather than the substance of being successful. He admitted he "gave no thought to any harm his actions might cause the university." Does this not resemble the behavorial pattern of financial industry wizards who, giving no thought to the possible harmful consequences of their dealings, did whatever they decided needed to be done in order to achieve success, both in terms of finances and in terms of image?

The law firm that was duped by the false resume altered its practices and now requires a certified resume from the law school rather than a resume transported by the student. By getting the resume directly from the school, printed on special paper and with other mechanisms for preventing alterations, the law firm took steps to remove an opportunity for a person to commit fraud. There is no reason that business and other schools cannot change their admissions process to identify not only applicants with criminal histories but also applicants with a record of engaging in fraudulent and dishonest behavior. There also is no reason for these institutions to be lenient when enrolled students engage in behavior predictive of dishonest practices in the workplace.

Ultimately, the steps that can be taken by employers, such as the law firm that was duped, and schools are nothing more than some form of quarantine process so that those afflicted with dishonesty disease can be kept away from people, places, industries, professions, and economies that can be harmed by manifestations of that disease. The excuse often given by those who object to undertaking a screening process of the sort described is that it doesn't address the underlying problem. That is true, but it doesn't negate the benefits of low-cost, high-yield examination of applicants' records, whether they are applicants to a school, to a profession, or for a job. The truth of the excuse, though, demands that society do more.

The time and place for dealing with dishonesty disease is early in a person's life and in the person's home. By the time a person is old enough to apply to law school, or for a job, that person's character has been formed. Their outlook on life, however acquired, will have been established. Though occasionally someone past adolescence will modify his or her character and acquire a new outlook on life, the fact that when this happens it usually makes the news indicates how rare these transformations are. It is always better to prevent problems than to seek solution, and the best prevention is the instillation of a code of integrity in the minds of the nation's young people. The message must be sent not only in words but by actions. Parents who lie to other people while their children are listening, or who object to disciplinary sanctions for their children's dishonest deeds, are not doing their children, or the rest of the world, any favors. They harm the children by enabling behavior that eventually gets the children in trouble. Persistent and serious dishonest behavior, as evidenced by the attorney in the case, is something that has its roots in the person's early life, years before law firms, bar admissions committees, or employers can intervene.

The recommendation of the Hearing Board of the IARDC is that attorney be suspended for three years. Counsel for the Administrator, who presented the case against the attorney, argued for either disbarment or suspension until further order of the court. The arguments made on behalf of that position, the arguments made on behalf of the attorney for discipline less severe that what the Board recommended, and the Board's reasoning for its conclusion are in the report and recommendation. They're worth reading.

When people ask how so much fraudulent activity, which fuels a significant portion of the current economic turmoil, could occur, a clue to the answer can be found in the apparent disinterest of business schools in the non-criminal fraudulent and other dishonest behavior of their applicants. The advice that must be given to schools and employers, which isn't new and which is beginning to find willing recipients, is to find ways to identify people with these behavorial traits early in the process and to refrain from letting people off the hook too easily. After all, the economic distress generated by the "money and image ahead of all else" culture hasn't let its victims off the hook so easily.

Why Tax Practitioners Must Be Good With Words, and Not Just Numbers

Many people think tax is "all about numbers." So claim the students who arrive in my office before or at the beginning of the fall semester, expressing trepidation about taking a course in which "the math majors and the accountants have the edge" in the A-grade collection game. I explain that they don't have an edge. They might even have a disadvantage, because if they haven't built up for themselves an expertise with the use of words, they will stumble at least as many times over language as the self-professed "mathphobic" will stumble over numbers.

A recent case in the Third District of the Texas Court of Appeals illustrates this point. The case isn't about numbers, though ultimately it involved whether or not some dollars would be paid by the taxpayer. The case was "all about words." In ICAN Enterprise, Inc. et al v. Williamson Co. Appraisal Dist. & Williamson Co. Appraisal Rev. Bd., the court held that aircraft hangars were not exempt from property taxation under a provision that provided an exemption for any "building used primarily for . . . aircraft equipment storage" and that met certain other requirements.

The taxpayer leased aircraft hangars from the City of Georgetown in Texas that were located at the Georgetown Municipal Airport. The taxpayer stored airplanes in those hangars. Generally, under section 11.11 of the Texas Tax Code, property owned by Texas or one of its political subdivisions is exempt from taxation if the property is used for public purposes. However, under section 25.07(a) of the same law, leaseholds in exempt property may be taxed, but section 25.07(b)(3)(A) provies an exception for leaseholds in property that "is part of a public transportation facility owned by an incorporated city or town and . . . is . . . a building used primarily for . . . aircraft equipment storage.

Because there was no dispute that the hangars are part of a public transportation facility owned by an incorporated city or town and that the hangars are buildings, the case turned on the meaning of "used primarily for . . . aircraft equipment storage." The taxpayer an interesting argument in its attempt to prove that it used the hangars for the storage of aircraft equipment.

Relying on the Merriam Webster Online Dictionary definition of an aircraft as a "vehicle (as an airplane or balloon) for traveling through the air," relying on 14 C.F.R. section 1.1 of the Federal Aviation Regulations definition of an aircraft as "a device that is used or intended to be used for flight in the air," relying on the Merriam Webster Online Dictionary definition of device as "a piece of equipment . . . designed to serve a special purpose or perform a special function, and relying on the Merriam Webster Online Dictionary definition of vehicle as "a piece of mechanized equipment," the taxpayer argued that an aircraft is a device, and that because devices are equipment, an aircraft is equipment. The taxpayer also argued that an aircraft is a vehicle, and that because vehicles are equipment, an aircraft is equipment. The court rejected this argument for four reasons.

First, the court noted that because tax exemptions are strictly construed against the taxpayer, the taxpayer had the burden of proving that it was entitled to the exemption. It resolved all doubts against the taxpayer, implying that the validity of the taxpayer's reasoning was doubtful. But the court did not stop with this point.

Second, the court noted that the statutory language of the exemption was for "aircraft equipment storage" and not for "aircraft storage." Thus, although aircraft may be considered equipment under the common meaning of those terms, it does not follow that an aircraft is within the phrase "aircraft equipment." The pairing of "aircraft" with "equipment" limits the exemption to equipment used in manufacturing aircraft or to allow the aircraft to function. Turning the tables in the dictionary definition on the taxpayer, the court noted that Webster's New Collegiate Dictionary and the Merriam Webster Online Dictionary definition both define equipment as "the set of articles or physical resources serving to equip a person or thing: as . . . the implements used in an operation or activity." The court also noted that phrases such as "auto part" does not include an automobile.

Third, the court looked to other provisions in the Texas Tax Code to determine how the legislature used the terms aircraft and aircraft equipment. It discovered that the sales tax has exemptions for aircraft and separate exemptions for aircraft equipment, suggesting that the legislature considers aircraft to be in a separate category from aircraft equipment. It also went beyond the Texas Tax Code, and explored the Texas Transportation Code. The latter distinguishes between aircraft and "aircraft-related . . . property, including . . . equipment."

Fourth, the court rejected the taxpayer's reliance on Federal Aviation Regulations. The court examined the provision cited by the taxpayer and concluded that it defines "[j]ustifiable aircraft equipment" as "any equipment necessary for the operation of the aircraft." The provision thus distinguishes aircraft from aircraft equipment rather than treating the two phrases as equivalents.

This case illustrates the importance being precise when using words. Yes, it would have been helpful had the Texas legislature elaborated on the terms "aircraft" and "aircraft equipment" for purposes of the property tax exemption in question. Presumably, the legislature assumed that people would understand that an aircraft is one thing and aircraft equipment is another, but it should have been cognizant of the tendency of lawyers, and even lay taxpayers, to turn and twist words if their usage provided any looseness whatsoever. That's the drafting lesson. The case also illustrates the importance of being precise when reading words. Though the taxpayer's argument appears to rest on a very precise analysis, ultimately it was insufficiently precise, because it did not foreclose the similar approach to working out the meanings that the court employed to reject the taxpayer's analysis.

The case also demonstrates why it is useful, and sometimes necessary, to look at other provisions, not only in the tax law but in the jurisdiction's statutes generally, in the effort to parse a particular statutory provision. A common mistake of law students is to consider the departure for purposes of examining those other provisions to be an irrelevant tangent. It might be a tangent, but it surely is not irrelevant. Long ago, I stopped counting the number of students who expressed dissatisfaction with one or another of my tax courses because I "go off on tangents." The web created by these so-called tangents provides the fabric on which statutory construction takes place. How students get to the level of the courses that I teach while still under such misapprehensions is a question that law schools, undergraduate schools, and even the K-12 education system ought to answer. I know the answer, but much more would be learned if those institutions answered the question for themselves.

Though people generally think of numbers as things that must be used with precision whereas many people think they can play fast and loose with words. Yet, at the most foundational level, words and numbers aren't mutually exclusive. They share much in common. Both are symbols or tools for communication. In ancient languages, such as Egyptian hieroglyphics and Sumerian cuneiform, words and numbers were represented by what most people today would call pictures. Romans expressed numeric concepts by using letters, and also used letters to express words. I'm nowhere near as familiar with languages such as Chinese, but I recall being told the same sort of similarity exists. Ultimately, words and numbers, just like power tools, must be used with care and precision. Otherwise, it might be something more than taxes that get cut.

Tax Consequences, Tax Compliance, Tax Policy

Tax law professors are well known for presenting students with hypotheticals and asking the students to analyze the tax and other legal consequences of the transaction. So let's look at a set of facts.

A non-profit social services organization offers its employees accounts in which it deposits something called Equal Dollars. Even the CEO of the organization receives $700 of his pay in Equal Dollars. These are not items of U.S. currency, but are scrip with the face of someone whose philosophy and examples are inspiration for the organization. The organization prints these Equal Dollars, in denominations of 1, 5, 10, and 20.

One day a week, vendors come to the organization to sell their wares. One sells earrings, another, Tupperware. Yet another offers baked goods, and still another markets pocketbooks. A person who wants to purchase something can pay in U.S. currency, Equal Dollars, or some combination thereof. The vendors use Equal Dollars to pay rent for the space in which they set up shop. In the same building in which the social services organization is located one finds a pharmacy, which accepts Equal Dollars in payment. The organization's CEO brings vegetables to sell to other employees for Equal Dollars. He also accepts Equal Dollars in exchange for teaching people line dancing and how to make pizza dough. A former employee of the organization continues to accept Equal Dollars in exchange for teaching people how to crochet. She uses some of those Equal Dollars to purchase earrings from the earring vendor.

But as I tell my students, law professors, including tax law professors, "don't need to make up this stuff." Paraphrasing from a decades-old leading Supreme Court case on taxation, one that addressed the concept of ordinary and necessary, I remind them that, "Life in all its fullness provides the examples." It also provides the clients whose business sustains tax practice.

So the preceding hypothetical isn't hypothetical. It's real. The facts come from Annette John-Hall's column in Monday's Philadelphia Inquirer, nicely titled The Currency of Bartering. She explains that the program started in 1996. It blossomed, reaching a point at which it had 864 participants, 298 businesses, and a newsletter with a circulation of 2,400. But for some reason the program fell dormant. Now, with the economy struggling, the program has had a resurgence. Its 200 members actively trade with each other. The program is making arrangements for a local credit union and a medical practice to accept Equal Dollars. The program has made an interest-free loan to another non-profit organization, which plans to use the money to hire someone, half of whose compensation will be in Equal Dollars.

John-Hall concludes her column by hailing the idea of privately-printed scrip: "More money to spend, more support for small businesses, and more cash to save or use for other means. In these economic times, I'd say it's a win-win-win." But is it? Will it be seen as all win when the IRS comes knocking on doors and stopping by vendors' booths?

There's nothing in John-Hall's column that indicates how the people using Equal Dollars treat them for tax purposes. Does the CEO's W-2 include the $700? Will the employee of the borrowing non-profit end up with a W-2 that includes only the amount of U.S. currency paid to her or will it also include the Equal Dollars? Do the vendors who accept Equal Dollars report those amounts as gross receipts? Does the pharmacy do so? What will the credit union and the medical practice report on account of Equal Dollars?

There are three major groups of issues implicated by this set of facts. One group of issues involves the tax consequences. The second touches on tax compliance. The third puts the spotlight on tax policy. Though the answers to the first two groups of issues inform analysis of the third, a student, just like a practitioner, needs to answer the questions that are posed. Too often, when faced with determining the tax consequences, students -- and too many law faculty -- jump into the wonderful world of what the law should be rather than providing to the client the assistance the client seeks. A client who is trying to comply might have some peripheral interest in how the world would be a better place if the answer were different, but the client isn't paying for that advice.

The consequences of the use of Equal Dollars should be easy to determine, but there is no explicit authority answering the question. Years ago, in Rev. Rul. 79-24, 1979-1 C.B. 60, the IRS concluded that gross income includes the value of property or services received in exchange for other property or services. About a year later, in Rev. Rul. 80-52, 1980-1 C.B. 100, the IRS concluded that the same result was reached even if the bartering was not direct but implemented by an organization crediting its members with trading units. Several years later, in Rev. Rul. 83-163, 1983-2 C.B. 26, the IRS concluded that members of a barter club must report gross income when they receive services through a barter exchange. The organizations operating these barter exchanges are required to comply with the barter exchange reporting requirements. The IRS has also concluded that organizations that provide a venue for individuals to exchange services on an informal, noncommercial basis and that do not give the participants any rights or impose any obligations with respect to the exchange are not barter exchanges subject to the reporting requirements. Thus, in private letter rulings, the IRS has concluded that nonprofit organizations issuing "Time Dollars" or similar credits for services provided by individuals to other individuals are not barter exchanges subject to the barter reporting requirements, chiefly because in the instances it reviewed, there was no guarantee that the recipient could get anything for the "Time Dollars" issued to the person. The IRS has specifically declined to answer the question of whether the participants in the program have gross income. Turning to the statute, unless an exclusion can apply, the recipients of the Equal Dollars have gross income because when they receive those dollars they receive something that has value, that can be used to acquire property or services of comparable value, and that are theirs to use unfettered by any restrictions or limitations. When one works through a list of possible exclusions, it's unreasonable to conclude that the Equal Dollars are received as a gift. A person who bargains to receive half of her salary in Equal Dollars isn't the recipient of a gift. Filling employee accounts with amounts that the employees can use to acquire goods or services isn't the making of a gift because transfers by employers to or on behalf of employees by statutory definition cannot be gifts. It's very difficult to conclude that the receipt of Equal Dollars represent imputed income, which the IRS as a matter of administrative practice declines to tax and which some theorists claim isn't income in the first place, because imputed income situations involve people doing work for themselves, such as mowing their own lawn or cooking their own meals. Consider, for example, the $700 of Equal Dollars received by the organization's CEO. How is that any different from receiving a gift certificate for $700 worth of services of products at a retail establishment? It isn't. Professor Deborah Geier has reached the same conclusion, in "When Helping Hands Have to Pay Taxes," an article published on page A24 of the January 22, 1993 edition of the New York Times.

As for the compliance questions, there aren't enough facts to determine what the organization and the participants are doing. Perhaps the recipients are reporting income, and perhaps they are not. Whether the details of the Equal Dollar program fall closer to the barter exchange or closer to the "Time Dollars" arrangement on the spectrum of "U.S. currency-free transactions" is unclear, and thus whether the organization described in John-Hall's column should be reporting cannot be answered at this point. The facts of the "Time Dollars" private letter rulings are sufficiently different from those of the "Equal Dollars" arrangements to make it risky for someone to reach a conclusion based on the general facts that fit into a newspaper column. Lurking in the compliance cluster is the situation that will arise when someone reports Equal Dollars as earned income in order to qualify for, or increase, the amount of his or her earned income tax credit.

The policy questions are important, and have as many answers as there are opinions to be set forth by tax experts, community organizers, non-profit organization executives and advocates, legislators, and citizens. If the transactions described in John-Hall's column were to be made the subject of an open-ended exclusion in the Tax Code, every transaction in the nation soon would be recast in Equal Dollars, and income tax revenues would vanish. Though the Tea Party crowd might rejoice at this outcome, their partying would end quickly when they dialed 911 and no one showed up or when they drove across a bridge and it collapsed. If the Congress created an exclusion limited in some way, it would create even more complexity and encourage people to squeeze into the exclusion transactions not intended to be within it. If the justification for exclusion is that poor people ought not pay income tax, is not the answer a personal exemption and standard deduction of sufficient size to permit people to avoid taxation if they receive small amounts of Equal Dollars but not if they receive a huge amount? Arguments for excluding these amounts from gross income are found in Vada Waters Lindsey, The Burden of Being Poor: Increased Tax Liability? The Taxation of Self-Help Programs, 9 Kan. J. L. & Pub. Policy 225 (1999). The programs discussed in the article, however, are significantly different from the Equal Dollars arrangements. For example, under the programs discussed in the article, the maximum that a person could receive in "Time Dollars" during a specific year was $2,000, whereas the description of the Equal Dollars program suggests that the amounts in question may turn out to be much higher.

In some ways, the use of Equal Dollars is tantamount to the creation of a separate currency system within the economy. So long as Equal Dollars can circulate only within the limited world that accepts their use, the tax issues aren't unlike those arising when a barter exchange or trading club sets up ways to measure members' economic positions through devices other than a national currency. If, however, the use of Equal Dollars or their equivalent become so widespread that they displace the use of national currency on a grand scale, the tax issues, especially the policy questions, will be cast in a totally different light. As for the issues that are not tax issues, others need to suggest the consequences and risks of issuing and dealing in these sorts of currencies. What, for example, will be the impact on the credit union's financial reporting and compliance with credit union regulations of accepting Equal Dollars?

Ultimately, the Congess needs to deal with these issues. Unfortunately, it, like most legislatures, usually waits until people sort things out for themselves, making it more difficult to prescribe sensible rules because a coalition of those wanting special exceptions, those wanting transition rules, and those unwilling to change their reporting practices prevent the legislatures from writing on clean slates. That has happened with digital technology, it happens with advances in biomedicine, and it is happening with the creation of substitute currencies. I wonder how many members of Congress understand that the issue exists, let alone understands the analyses applicable to dealing with the issues. And why has the IRS declined to give the nation guidance on these questions? What concerns cause it to hesitate?

An Elite Law Student Coalition to Break Law Firm Elitism?

A recent article in the National Law Journal, Could Collective Action by Students From Top Law Schools Change Firms? raises some important questions about the way law firms conduct business, the relationship between law schools and law firms, and the extent to which law students have the power to change the law practice world.

The article describes a meeting of roughly four dozen students from "premier law schools," including Stanford, Harvard, Yale, and Columbia, at the National Conference of Student Leaders sponsored by the Building a Better Legal Profession (BBLP). The goal of the BBLP is to reform law firm practices with respect to billable hours, diversity, the treatment of women and minorities, and pro bono. The BBLP, and others, are critical of the number of billable hours expected of associates, question the use of the billable hour, have concerns with respect to diversity, and are disappointed with what they perceive as a lack of commitment to pro bono work.

According to the student leaders from these elite law schools, the solution is for students from these schools to not take jobs at law firms whose business practices run afoul of the standards set by the BBLP. This proposal appears to rest on the assumption that law firms would find it detrimental in some way to be rejected by students from these schools, and that in an effort to bring them into the firm would revamp how they operate. Quoting a second-year student from Stanford Law School, ""Over time, firms with low diversity numbers, poor female partnership rates, high billable hour requirements and poor commitments to pro bono will risk year after year of associate classes without graduates from the country's top law schools." Between the lines of that statement is the notion that law firms who lack graduates from these elite schools will experience some sort of disadvantage.

The issue isn't whether law firms need to work through some serious problems in terms of billing practices, minority hiring, and pro bono efforts. The issue, as often is the case with lofty goals, is how to accomplish a goal which almost everyone accepts as praiseworthy. How realistic is the plan advanced by these law students?

The plan put forth by the students from the elite law schools appears theoretically sound, but it has serious practical problems. That's not surprising, considering what these law students have been experiencing for the past several years.

First, to be effective, this approach would require full participation. Though refusing to work at a law firm that doesn't measure up to a student's standards may salve a student's conscience, that refusal is unlikely to have any impact on the firm. If the student doesn't tell the firm why he or she has turned down the offer, it's almost certain that the student's protest is in vain. Students decline employment at law firms for a variety of reasons, many of which are tied to a student's perspective on life, morality, theology, lifestyle, or other preferences. The BBLP, at best, is adding to the list of reasons to pass up on a particular law firm, but that, in and of itself, isn't going to change anything.

Second, assuming all of the students at these elite schools jump on the bandwagon, it is highly unlikely that any law firm will change its ways because it no longer can hire students from these schools. Law firms will discover that there are other students available to be hired. Law firms will discover that students in the top ten or fifteen percent of any graduating law school class are gifted and capable of practicing law in any law firm. Law firms might even discover that graduates of non-elite law schools are more prepared to practice law than are those of the elite schools because their education has been focused more on practical matters and less on theory. They are somewhat more likely to have been in an environment where faculties focus more on teaching than they do on "writing for other scholars." Once law firms make this discovery, and get past what is another problem with many big law firms, the addiction to the brand or label, they may settle in with what will have turned out, serendipitously from the firm's perspective, to be a better situation. These firms may not be in much of a hurry to rush back to on-campus interviews at the elite schools.

Third, magnifying the point of the previous observation are the economic consequences of a law firm turning to the elite students at non-elite law schools. Law firms will discover that these students, perhaps because their tuition was slightly or more than slightly less than those paid by the elite schools' students, are willing to work for slightly or more than slightly less pay. From the law firm's perspective, what better incentive is there to modify hiring practices?

Fourth, at a time when many law firms are not making employment offers, self-removal from the hiring process isn't going to have much of an effect, if any. At the moment, it's an employer's market. Potential employees have little leverage. One might suppose someone learns this in law school, but perhaps when one is learning more about the way the world would be if the law faculty ran the planet and less about the way the world actually is, it's easy to miss out on the niceties of leverage in the marketplace.

Fifth, to the extent that the BBLP effort succeeds with respect to billable hour practices, the outcome very possibly would be a further reduction in associate salaries. Consider the flaw of the billable hour. A client needs a problem to be solved or some planning to prevent a problem. The law firm takes the matter, and assigns it to a young associate who is billed out at $300 per hour, to be supervised by a patner who bills at $600 per hour. The associate initially invests ten hours in the matter, and a supervising partner invests five hours reviewing the associate's work, explaining what is wrong and needs to be fixed, and the associate invests another seven hours, followed by the partner putting in another two hours. The client is billed $5,100 for the associate's time and $4,200 for the partner's time, a total of $9,300. The client asks how much time would have been charged had the partner simply done the task. The partner would have been able to take care of the matter in eight hours. The invoices would have been for $4,800. Even if the partner has another partner invest an hour to eyeball the work to make certain there are no errors, the client's cost would still be significantly less than $9,300. The inefficiency in this approach is apparent. The client is paying for the partner to teach the associate, because the associate, despite having attended law school, is unable to deal with the matter. Contrast this with a business that charges a fixed-fee. Assume a lawn mowing company charges $50 to mow a one-half acre lawn. The company generates this fee in part by looking at what the competition charges, but also at what its costs will be. It knows that a good lawn mowing employee can mow a one-half acre lawn in an hour. It knows that the market is such that the employee must be paid $30 per hour, that fuel for the mower will be $5 per hour, that the lawn mowing equipment is amortized to $6 per hour, that insurance is $2 per hour, and so on. To be profitable, this business must make certain its employee gets the job done in an hour. If a person doesn't know how to mow the lawn properly within an hour, the person is history with that company. Alternatively, the lawn mowing company could pay the employee on the basis of work done, so that if the employee needs twice as much time to do a fixed number of lawns, the employee's pay is cut in half. Carrying these models to the law firm, most law school graduates would not be earning $150,000 or more but less than $50,000, and that's being generous. At those salaries, the elite law schools charging brand-name tuition rates become economic failures. At those salaries, would these students nonetheless attended law school? If so, why aren't these students simply taking the legal positions that pay $40,000? If they need or want the $150,000 salaries, are they not going to need to put in thousands of hours a year in order to produce enough acceptable work to justify the pay? Or do they think that because their teachers kept tagging them as A students in elite schools that their law firm work product is per se wonderful? Granted, it's not their fault, but how loud have their voices been in criticizing the deficiencies in their legal education?

Sixth, the proposal is flawed because it is hypocritical. For the most part, the business practices that are under scrutiny are variants of elitism. Inattention to pro bono concerns, the limited number of female and minority partners, lack of diversity in hiring, and most of the other complaints made by the BBLP originate, to a greater or lesser extent, in elitism. The sense that "we are better than you" tends to be reflected when there genuinely is gender, racial, religious, or other discrimination, when there is disregard for the plight of the less fortunate, and when there is a willingness to price one's self at the high end of the law practice cost scale. Yet is there not elitism in the gathering of students from a handful of premier law schools to the exclusion of students from other schools? Is there not elitism in the notion that there is a good reason for employers to favor graduates of these schools, even though studies show that over the long run, there are just as many good and excellent lawyers coming out of second, third, and fourth tier law schools? None of this is surprising, for throughout history, reform movements targeting elitism have themselves often been elitist. One need think only of Communist Party officials in the former Soviet Union who owned dachas inaccessible to the peasants. So much for egalitarianism.

Having criticized the BLPP's approach to dealing with what are legitimate and real concerns, I ought to propose an alternative. Here's one. Ought not these elite students from elite schools have sufficient education, intelligence, motivation, and savvy to form their own law firm or firms, built on principles consistent with their views, that over time will become more attractive to clients who share these views? Would that not erode the revenue sources of the firms that these students have tagged as having unacceptable business practices? When and if these students respond that they don't have what it takes to do this, ought not these elite students from elite schools undertake to sue their alma maters for having failed to prepare them for the very profession they claimed they were readying their students to enter?

There is no question that law practice needs to change. There is no question that lawyers, law faculty, and law students need to be involved in encouraging, energizing, inspiring, and compelling the changes that will improve the practice of law. The effort needs to be universal, and not the domain of a select self-appointed elite. The effort needs to be cooperative and persuasive. Creating forums in which law students and associates can communicate with, and educate, partners is far more helpful than turning up one's nose and walking away without ever engaging the partners in a candid disclosure of the issues. Surely the elite can figure this out.

A Sort-of Flat Tax on Wages? Another Bad Tax Reform Idea to be SET Aside

The New York State Society of Certified Public Accountants (NYSSCPA) has dusted off its Simplified Exact Transparent Tax (SET) proposal, which it describes as a simplified tax code. Back in 2005, the NYSSCPA presented its SET proposal during the superficial tax reform excitement that ultimately led to nothing. With a new Administration in office, the proposal has returned to the NYSSCPA center stage.

Under SET, there is one tax rate that applies to income reduced by statutorily defined exclusions. That's the first time I've encountered the concept of an exclusion as something that is included and then subtracted out. An exclusion is something that doesn't go into gross income in the first place. After reading several sentences of the report, I'm already leery of the quality of the thinking underlying the idea. According to the report, the tax computation would begin with gross income, which the report describes as the "broadest income base possible and the easiest to teach and understand." Really? Try teaching section 86, section 132, or even the basic concept of gross income. What is income? What is realization? What is "clearly realized"? Deep in the report is this claim: "Gross income is ALL income. Income would be measured under existing principles….There would be no omission from realized gross income, only deductions we call exclusions." Sorry, but that doesn't simplify anything. In fact, by calling deductions exclusions, the proposal muddies the tax water.

SET would provide exclusions for gifts and inheritances. Ask any law student who has been enrolled in a well-taught basic income tax course to define gift for income tax purposes. Any student who pays attention knows that the simple black letter law, gifts are excluded from gross income, generates its complexity when it is time to apply the simply-stated rule to the reality of life's facts. SET would continue treating loans as items that are not income. So the ongoing tension between IRS and taxpayer, include decades of litigation, concerning the distinction between a loan and a dividend, a loan and compensation, a loan and equity, will continue. There's no simplification in this aspect of SET. The report continues to suggest that exclusions could be provided for care giving, home mortgage interest, state taxes, charitable contributions, and taxes on capital income. How is this not the reintroduction of all the complexities that the comparable deductions and credits presently offer? What happens to imputed income? To amounts received in kind? To fringe benefits? What happens to retirement income? What happens to amounts set aside for retirement? The only credits under SET would be refundable credits to benefit low-income taxpayers, and perhaps a foreign tax credit although an exclusion equivalent would be another way of dealing with the taxation of foreign income.

The goal is to allow everyone to file their tax returns on a one-page form. Good luck. What happens if there is a long list of exclusions, as surely will happen as Congress continues to tinker with tax law? Will the subtracted items fit on one page by reducing the font of the typeface to point 3?

The NYSSCPA claims that SET will permit progressivity even though it uses only one rate. That is done, apparently, through use of a lump-sum exclusion for lower income taxpayers. This can generate progressivity, but it is not a very steep progressivity. The rate? Thirty-three and one-third percent. Even though proposing this rate, the NYSSCPA does not endorse it. I'm still trying to figure out what that means. Perhaps it's similar to someone making a motion simply to permit discussion of an idea which the person opposes, either as a gesture of fairness and open dialogue or as a ploy to find a venue in which to criticize the motion. The report, almost as an aside, mentions the possibility of having a scaled lump-sum exclusion, which appears to have some of the trappings of a phaseout.

The NYSSCPA characterizes SET as superior to other flat tax proposals because most other proposals remove people from the tax rolls. SET would require everyone to file, a goal that the NYSSCPA thinks is important because it prevents people from feeling "detached from government." Allegedly SET will make it easier to find tax cheaters. How? Every citizen would be required to file a return, and a person who fails to file would be treated as a tax evader.

Is there any good news with SET? It would eliminate the alternative minimum tax. It appears it would eliminate the phase-outs that create "bubbles" in the marginal rate structure. From the summary, it appears that it would eliminate the preferential special low tax rates for capital gains and dividends. But, alas, the report also proposes the possibility of an exclusion for capital gains and an exclusion for dividends. Is this a wage tax in disguise?

That good news is insufficient. This quote from the report explains why: "Most of the complicated parts of the Internal Revenue Code would be retained merely as building blocks and protective mechanisms to address the complex business and financial transactions that are the hallmark of our ever-evolving system of capitalism." So the simplification is accomplished by doing simple things with complex building blocks? In other words, hide the complexity behind a single rate, as though the complexity of the tax law is attributable to multiple rates. The least challenging task in preparing a tax return is looking up tax liability in a table or causing software to compute it.

Nothing in SET addresses the complexity caused by timing issues, as taxpayers generally seek to postpone income and accelerate deductions and exclusions. Nothing in SET addresses the complexity caused by taxpayers who try to structure transactions to avoid income, an issue that the NYSSCPA admits will continue to vex the tax world as it explains, " Existing rules are used to distinguish between income and loans, gifts, inheritances, support, and so on, as well as to handle issues of when income is 'received' in complex situations." SET would retain one of the more complicated areas, tax-free reorganizations, and the report explains, "Current law definitions will be very helpful in this area, and retained." Those definitions may be helpful, but they're wildly complex, as entire tax courses are devoted to the study of reorganizations. SET would retain percentage depletion through the use of a percentage depletion exclusion. Why?

Ultimately, although doing a few good things, SET simply turns deductions into exclusions, retains some of the most offensive aspects of the current income tax system, and creates, in effect, a tax on wages. Yet it is hyped as some sort of panacea to every problem facing the nation. It's as stale and misguided as the tax policies implemented during the time it was first proposed, and it has about as much chance of seeing enactment as the outcome of the tax reform proposals that were issued during that same time frame. The SET tax proposal should be set aside.

Tax Day Trivia

My librarian friend gave me a Christmas gift that is paying dividends (of the nontaxable sort) every day this year. It's a calendar of "Forgotten English." Each day brings a word, only a few of which I've previously seen, a definition, and some trivia with some connection, close or remote, to the word. My friend is trying to expand my vocabulary beyond the narrow confines of tax law, genealogy, and trains.

Today's word is catchpole. Look it up.

The trivia involves taxes. Is there a connection with catchpole? Yes, a slight one. The trivia, though, is fun. Two tidbits are shared.

Did you know that Virginia permitted its citizens to pay taxes in kind, specifically, by transferring beef to the tax collector? What did the state government do with it? Sell it? Give it away? Back in 1781, one tax collector realized that he wasn't going to succeed in collecting beef, so he permitted the taxpayers to transfer "the same quantity of pork." Now there's a reversal. Instead of a government dishing out pork, it was collecting it. Talk about gross income.

Did you know that in the Netherlands there once was a tax calculated according to the length of the taxpayer's surnames. This caused people to abbreviate their names to monosyllabic versions. I suppose the best my distant relatives could have done would have been to drop the "e" but I haven't yet found very many of the family in Holland. My Dutch ancestors had, and seemed to retain, rather long names. But imagine. Could genealogy research have been made more challenging because of a tax law? How outrageous is that?

Fortunately, the First Amendment would pose some obstacles to a tax based on the length of blog posts or emails. Am I glad for that? Yes.

The Return of the Soda Tax Proposal

Monday's Philadelphia Inquirer featured an article, the name of which, Cut Calories by Taxing Soda, almost says it all. According to the article, Kelly D. Brownell, director of the Rudd Center for Food Policy and Obesity at Yale University, has wiped the dust off of his 1994 proposal to impose a one cent per ounce tax on sugared drinks. Although, according to Brownell, he "got blistered" in 1994, he's ready to try again because during the past 15 years obesity rates, particularly among children, have increased and governments find themselves in need of revenue. Together with Thomas R. Frieden, who is New York City's Health Commissioner, Brownell published a report last week that "daily caloric intake from sugar-sweetened drinks rose nearly 30 percent in the last decade." They estimate that the one cent per ounce tax would generate $1.2 billion in annual revenues in New York State. Whether that refers to a state tax, or combined state and local taxes, isn't clear. No matter, it's a good chunk of change.

The idea of imposing so-called "sin taxes" as a way of reducing government budget deficits isn't new, and has grabbed the spotlight in recent months. As I pointed out in Taxing Barbie, detrimental behavior that does not infringe on another person's rights usually is not criminalized, but taxed. I noted the taxes on tobacco, alcohol, and gambling, and mentioned proposals to tax fast fook, carbon-based fuels, ammunition, and furs. More specifically, the idea of taxing non-diet soda and other sugar-containing beverages was included by New York's governor in his recent budget proposal. In What Sort of Tax?, I discussed the proposal. I questioned whether it made sense to single out soda, or soda and certain beverages, if the purpose of the tax was to increase the cost of behavior that contributes to obesity. I explained, though one might think it should not need explanation, that non-diet soda soda isn't necessarily any worse than other foods when it comes to causing obesity. Even low-calorie foods, when consumed in sufficient quantity, can cause a person to gain weight. The authors of this essay on the question volunteered that when they asked the New York State Health Commissioner about this point, he replied that if economic needs justified extending the tax to "other high calorie foodstuffs [such as] cheeseburgers, pizza, and snack foods," he would do so.

Not surprisingly, there is opposition to the imposition of taxes on non-diet soda and similar beverages. Some opposition can be found among those opposed to taxes on general principles. Some opponents, such as the American Beverage Association, claim that soda has little or no effect on obesity. Others claim that the tax would affect poor people, which is true of most sin taxes. Still others claim that popular opinion disfavors the tax, although others claim that their polls show the opposite if the funding is directed into public health programs.

The sort of tax in question is much like a user fee. User fees make sense when they are related to a burden that the taxed item or activity imposes on society. A user fee is equitable when it treats all similarly situated items or activities in a comparable manner. No tax or user fee ought to be imposed simply because it can be imposed, or simply because a government prefers to increase its revenue. Some sort of justification is required. In this instance, if the purpose of the tax is to pay for the cost of ingesting excess caloric intake, then the tax needs to be tailored in a manner that doesn't focus the "blame" on specific foods or beverages. The administrative difficulty with excess caloric intake is that no food or beverage can be singled out as the cause, and yet every food and beverage can be the cause. Any food ingested in sufficient quantity can be unhealthy. If the justification for taxing soda is that it contributes to obesity, what is the sense of imposing the tax on a non-obese person who makes the purchase? That question illustrates the administrative problem, because the purchaser may not be the actual consumer.

In theory, the best tax or user fee designed to reduce obesity should be a tax or fee based on weekly weigh-ins. That sort of tax would be near-impossible to administer. Who would do the weighing? How would cheating be prevented? Who would handle the dispute about scale accuracy? Compliance surely would be a huge problem, no pun intended. But if the next best thing is a tax on foods and beverages that are more likely to contribute to obesity, then singling out beverages containing sugar appears to be nothing more than the pet project of the artificial sweetener lobby. What about those cheeseburgers and, I daresay, peanut butter cups?

Would not a tax on sugar-containing beverages compel at least some people to use alternative items? Would this not heighten the battles among the various sugar-substitute manufacturers, each of whom is eager to point out the health risks of their competitors' products? If the tax were successful, to the extent that everyone switched to diet whatever, would the tax not be successful in the sense that it would no longer raise revenue?

Why the focus on obesity? Is there not also a concern about excessive thin-ness? Does not being underweight pose health problems? What would happen if there were a tax on failure to consume sufficient calories? If the answer is that someone who eats too little already suffers enough, cannot the same be said about the obese?

Think also of the other dietary practices that adversely affect health. Consumption of sugar-containing beverages can be detrimental to one's well being. But so, too, can be a diet devoid of vegetables. Will the meat and potatoes crowd be the next target of the healthy lifestyle advocates? Would a tax on caffeine be helpful to societal well being because it might reduce the number of over-caffeinated individuals roaming the planet?

My perspective isn't that of someone who doesn't care about proper nutrition. I gave up soda (or pop, or soft drink, or whatever one calls it) a long time ago, chiefly because I preferred to avoid the carbonation. I've cut my weight by trimming down my intake of those chocolate chip cookies and peanut butter cups, among other things. I exercise. So I very much would like to see a nation of fit and healthy people, for a variety of reasons into which I presently will not delve. I simply don't think that a tax on sugar-containing beverages, or even a tax on supposed unhealthy foods, will make a difference, because it doesn't attack the root cause of the problem. What activity or item can be taxed when the problem is a psychological one rooted in lifestyle and culture? Even if it could be identified, and I don't think it can be, would it be appropriate to tax it? No.

Could the IRS Have Been the Hero? Should It Have Been the Hero?

A new study from the Transactional Records Access Clearinghouse (TRAC), New Agency Data Shows IRS Downgraded Large Financial Services Audits provides some disturbing information and raises some serious and challenging questions. According to the report, in 2008 the IRS audited only 15% of large financial services companies even though it audited 64% of other large corporations. The first question that comes to mind is, "Why?" The report also asserts that the audits of the financial service industry were "less thorough" than those of other industries. Again, the question is, "Why?" These concerns are not new, as indicated by earlier TRAC studies cited in the latest report. The TRAC report itself asks, "Did the decision of the IRS to cut back on its financial services audits in a direct or indirect way contribute to the failure of the government to uncover the criminal schemes of Bernard L. Madoff and others like him in a timely manner?"

The answers to the first two questions are known only to those persons at the IRS responsible for determining the extent and scope of audits. The answers may have something to do with resources, and may have something to do with perceived audit needs in other industries. There may have been empirical evidence indicating that noncompliance by other taxpayers was increasing at an alarming rate. The answers will not be known until someone, somehow, persuades the IRS to inform the public. Until then, it's a matter of guessing.

The answer to the third question is impossible to determine. Even the IRS doesn't and cannot know. It is possible that in the course of a tax audit, the IRS would discover that Madoff or someone acting as he did had recycled dollars in a Ponzi scheme. It is also possible that this would not have turned up. Perhaps, if the IRS did discover something sinister, it would have passed the information along. That is a guess, but it is probably a very good guess. The IRS does have a history of cooperating with the Department of Justice when criminal behavior comes to light through tax audits. On the other hand, whether it would send information to other agencies, such as the SEC, is a more difficult question to answer.

For me, there is a fourth question. It is the product of my increasingly cynical mind, the mind that sees relationships woven among life's patterns. Is it mere coincidence that during the same time that federal regulators were backing off close supervision of the financial services industry, the IRS also began backing down on the number of audits of that same industry? Could the industry's representatives and lobbyists have been so effective in their "get government off of people's back" campaign that there was a government-wide retreat? How can lobbyists be that effective? Do they speak with golden tongues? Do they make arguments so effective that no one ever, ever could deny that non-regulation of the financial services industry is the best ever thing for the American economy? Did they engage in behavior itself no less criminal than much of what transpired behind the closed doors of a loosely and perhaps phantomly regulated industry?

Hindsight is so amazing. I wonder how many people who were sucked into the "minimize or eliminate government, end taxation, give us freedom" movement now think to themselves, "Hmm. Who got the freedom from this deregulation and what did they do with it? Perhaps they decided they were now free to hoodwink and defraud the typical citizen." Much like the folks in the town that reduced taxation due to citizen pressure and then found itself in turmoil when reduced revenues required laying off half of the police force, to the consternation of the citizens, Americans may be discovering that the pied pipers of reduced taxation and deregulation masquerading as freedom were thinking not of the nation or their compatriots, but of themselves. Perhaps more IRS audits would have made a difference. Perhaps not. Perhaps the SEC and the other relevant regulatory agencies could have and should been more diligent in their examinations of the industry's activities.

Isn't it interesting, though, how, when things turn out badly, there's an implication that the IRS should have done more to prevent the problems. Yes, the IRS, that agency so despised. Despised, of course, until people begin to figure out that perhaps it really isn't their enemy.

A Special Tax Break: Fair? Worth Making Permanent?

This latest tidbit falls into the category of how the tax law becomes complicated and raises the questions of why a complication should exist and why an existing complication that is scheduled to expire should be extended. What's at issue is section 168(i)(15) of the Internal Revenue Code. Section 168(i)(15) defines "motorsports entertainment complex." Why is that definition required? It is required because section 168(e)(3)(C)(ii) of the Internal Revenue Code provides that a motorsports entertainment complex is seven-year property, which means that in computing taxable income the owner of a motorsports entertainment complex can deduct its cost over an eight-year period, rather than over the longer periods that otherwise would apply, 39 years for buildings and 15 years for land improvements. Section 704(a) of the American Jobs Creation Act of 2004, Public Law 108-357 added section 168(e)(3)(C)(ii) to the Internal Revenue Code, and with subsequent extensions, made the change effective for property placed in service after October 22, 2004, and before December 31, 2009.

Why this special provision for a very small group of taxpayers? The Joint Explanatory Statement of Committee of Conference for the American Jobs Creation Act of 2004 does not give a reason. It simply states existing law and states what the new provision does. The House Report to the 2008 extension contains two explanations. It states that the "Committee believes that extending the depreciation incentive will encourage economic development." It also states that the "Committee also believes that taxpayers should not be required to recover the costs of motorsports entertainment complex beyond the useful life of the investment."

Within the past few days, a bill was introduced in the house to repeal the termination date and make the special tax break for motorsports entertainment complexes permanent. The language of the bill, which can be found through the Library of Congress web site by searching for H.R. 1974, is quite simple. It gives itself a name, the "Motorsports Fairness and Permanency Act of 2009" and then provides for the repeal of section 168(i)(15)(D). The bill was introduced by "Mr. THOMPSON of California for himself, Mr. HELLER, Ms. BERKLEY, Mr. DAVIS of Alabama, Mr. LEWIS of Georgia, Mr. MEEK of Florida, Mr. BACHUS, Mrs. BONO MACK, Mr. BOUCHER, Mr. BRALEY of Iowa, Mr. BURTON of Indiana, Mr. CARSON of Indiana, Mr. COURTNEY, Ms. FOXX, Mr. FRANKS of Arizona, Mrs. HALVORSON, Mr. HASTINGS of Washington, Mr. HILL, Ms. KOSMAS, Mr. LOBIONDO, Mr. MCHENRY, Mr. MCHUGH, Mr. MICA, Mr. MOORE of Kansas, Mrs. MYRICK, Mr. PERRIELLO, Mr. SCOTT of Georgia, Mr. SESSIONS, Mr. WESTMORELAND, and Mr. CROWLEY."

How does this provision make the tax law more complicated? It requires the addition of 205 words to the Internal Revenue Code, numerous words to IRS Publications and instructions to forms, and countless words in professional publications, letters to clients, and web sites. For example, does the special break apply to the cost of racetrack warehouses? To the cost of vending stands? To the cost of fences? How many motorsports racing events must take place to qualify the facility for the special tax break?

Does the special tax break indeed encourage economic development? How has the economy fared since 2004 in the towns that have motorsports entertainment complexes? If those places are pillars of economic robustness, ought every town in America find developers to build these complexes? Assuming that the special tax break encourages economic development, why is there a special tax break for this activity and not for other activities? Are there locations whose economic track record (ha ha, sorry) surpasses those of towns with motorsports entertainment complexes? If so, why not a special break for whatever it is that people in those locations are doing? Are they not doing something even more valuable for the economy?

Does the special tax break prevent taxpayers from requiring the costs of motorsports entertainment complexes beyond their useful lives? In the absence of the special provision, the buildings would be depreciated over 39 years, as are factories, offices, shopping centers, and other non-residential structures. In the absence of the special provision, the other facilities and equipment would be depreciated over 15 years. Is the useful life of a motorsports entertainment complex less than 15 years? Many have been around for decades, and many still use facilities constructed a long time ago. Where is the evidence that after 7 years, the facilities are ready for demolition?

Why is the word "Fairness" in the title of the recently proposed legislation? What is fair about making permanent a special tax break when other taxpayers don't have a similar break and still others who have special breaks aren't candidates for permanency? Is it, perhaps, fair to the members who sponsor the bill so that they have a fair chance of gathering more NASCAR votes? Is that what's behind this proposed legislation?

When legislators bemoan the complexity of the tax law, do they ever look in the mirror? Do they truly understand the economics of the situation? Do they rely on their staffers? Are their staffers experts in this area? Are the legislators and their aides simply doing what their major contributors tell them or their staff to do? Has anyone produced proof that this special tax break has done anything other than reduce the taxes of a very small, select few taxpayers?

And what's the need for this special tax break? Taxpayers suffering from the economic meltdown are buried in losses and don't need accelerated depreciation deductions. They would be just as happy, or even happier, with depreciation extended over longer periods of time. Someone who owns a motorsports entertainment complex anticipates needing this special tax break in 2010 and thereafter. This someone must have some chunk of income that they want to shelter. This someone isn't buried in losses on account of the economic meltdown.

This legislation would do absolutely nothing to increase the take-home pay or improve the economic condition of motorsports fans. How has the introduction of this special tax break in 2004 affected their economic situation during the past four years? Are they better off than they were before it was enacted? Will they ask themselves this question the next time they enter a polling place?

It's unfortunate no one has introduced legislation to repeal section 168(e)(3)(C)(ii) and section 168(i)(15). That could be called the "Small Bit of Permanent Tax Fairness Act."

A Tide of Change in Legal Education: A Crisis That Won't Simply Go Away

In How A Transformative Recession Affects Law Practice and Legal Education, I examined the impact of the current recession on law firms, including their relationships with law schools, and extrapolated these developments into a prediction about the future. With clients demanding lower hourly rates and elimination of inefficiencies from the rendition of legal services, and with firms rescinding offers, curtailing or terminating summer programs, and showing the door to associate after associate, the legal world, I noted, is watching "one more nail in the coffin of legal education as we know it" get pounded home. I predicted that the quality of applicants to law schools will decline, that the number of law students will decline unless law school tuition is adjusted to reinvigorate demand, that law schools will need to increase faculty teaching loads and cut back on "scholarship [written] for the benefit of other scholars," and that we might even see the practice world, perhaps a combination of law firms cooperating with bar admissions committees and state supreme courts, establish schools that prepare people to practice law so that their salaries can be justified to the law firm's clients.

In Law Schools, Teaching, Legal Scholarship, and the Economy, I examined Richard Posner's proposal that law schools have a department of legal doctrine. I suggested that law schools, or more precisely, their parent universities, need to separate law teaching and legal institutes so that law school tuition funds education and some other sort of funding, if it exists, sustains the legal think tank. I noted that law faculty need to wake up and get in touch with the realities of what is happening in the law practice world, and that law schools are not insulated from the impact of this sea change in the world economy.

I posted those thoughts on March 16 and March 27, respectively. What feedback came my way was notoriously private, that is, people agreed with me but were unwilling to go public. Understandably, they had more to lose than do I, or at least are in a more difficult position than am I, from challenging the legal education establishment as it presently exists. It's not so much the reluctance to criticize, for it's easy to find people critical of modern American legal education, both inside and beyond the walls of the nation's law schools, but a reluctance to come across as a prophet of doom. There is legitimate concern that when a dean or someone in a comparable position of authority within the academy publicly agrees with the sort of predictions that I am making, there will be a self-fulfilling prophecy that can come back to haunt the person as those hurt by the changes seek to put blame somewhere other than on themselves. Although encouraging voices from within legal education continue to be in short supply in the public forums, more and more commentators outside the academy are chiming in and making many of the same arguments, and predicting many of the same outcomes, as I have been offering.

On April 1, Adam Cohen, in With the Downturn, It’s Time to Rethink the Legal Profession, also looked at the recent developments in the legal profession, and concluded that if there is a "silver lining" to the bad news, it's "that the legal world may be inspired to draw blueprints for the 21st century." He predicts a drop in associate compensation. That's already beginning to happen. He also predicts that lower compensation means that associates will not need to work as many hours. I disagree. The economics of law firms is that law partners think it's more profitable to hire fewer associates to do more work than to hire more associates to do less work. I'm not confident that the perspective of the partners on this issue will change very much. Cohen predicts that the billable hour may disappear. He's probably correct. Then he turns to legal education and, after noting the scale of law graduate debt loads, suggests that law schools "will need to keep tuition and other costs in check" so that students can move into the profession without being saddled with "unmanageable debt." He wonders if more schools will follow Northwestern's lead and offer two-year programs. What he doesn't mention is that the total cost of the two-year program, as it now exists, isn't a 33% discount from the cost of a three-year program. In fact, it's barely cheaper and carries the obstacle of blocking out summer employment income, though at the moment there's not much in the way of summer employment income available. Cohen also emphasizes the need for law schools to "become more serious about curriculum reform," with "more pressure on schools" to add "more focus on practical skills." He suggests that law schools should "pay more attention to preparing students" to end up in "business, government, journalism and other fields." Though I share Adam Cohen's outlook, I must warn that those who "draw blueprints" are those who realize there's a need for a new building or a rehabilitation of an existing one. I'm not yet convinced that law faculty generally understand the need for some heavy-duty construction and reconstruction of legal education. Deans do. But deans are not CEOs and it remains to be seen what they do after they trim budgets and work with the financial statements.

On April 6, Katharine Patterson, a long-time legal recruiter and HR management consultant, brought her extensive experience and "in the middle of all of it" perspective to bear in Tough Times for Law Firms, Lawyers May Be Catalyst for Positive Change. Drawing on the impact of the last three major legal recessions on the profession, she, not unlike Adam Cohen, points to the current difficulties as an opportunity for productive change. She predicts the demise of lockstep compensation, the growing use of "more dynamic models that account for productivity and contributions to the firm's long-term institutional identify," and the disappearance of, and I think this is a great phrase, the "donkey and carrot race for partnership." She, too, turns her eye toward university campuses. She tells us, "Law school hiring will change. On-campus hiring will move to the end of the second law school yar, and look a lot more like business school recruiting." She thinks students increasingly will seek admission to two-year programs or "schools that offer stronger internship and practical training opportunities beyond academic legal training." As did I, she uses the "nails in that coffin" language to describe the impact of the recession on the way things have been done in the past, such as institutional loyalty. She then makes a point that I've also heard, in somewhat different terms, from someone who is a law school dean. She explains, "The current generation of young lawyers and law students is cursed not just by its lack of experience of hard times, but by an egocentricity born of good times. They just don't know how to behave, and can come across as self-centered and childish." Amen. Sadly, I can say the same thing of many who are on law school faculty, who have been able to ride a student debt bubble into a journey of writing scholarship for which no market has been, is, or will be willing to pay. I wonder how many deans will use the words "egocentricity" or "self-centered" when describing the reactions they encounter when they break the news that course loads are increasing, scholarship no longer holds center stage, and teaching, as measured by performance of the school's graduates, will be more of a factor in tenure and compensation decisions.

Perhaps all of this turmoil will indeed bring worthwhile change. The change needs to be more than structural. It needs to be more than shortening or lengthening the number of years one enrolls in law school. It needs to be more than incorporating law practice skills into the curriculum. It needs to be more than increasing faculty course loads and decreasing the time invested in scholarship for other scholars. The change needs to reach into the heart of law school culture. Law schools need to be more demanding of their students academically and to be more willing to dismiss those who cannot accomplish what law practice demands. Law schools need to put an end to relying on the useless portions of student evaluations of law teaching, and need to stop playing to the U.S. News rankings. Both best serve legal education and society by being dumped into a landfill. Both have contributed to the current failings of law schools, as the first causes law faculty to play the popularity contest game at the price of giving up the important quality of being demanding and the second has encouraged law faculty to churn out scholarship for other scholars, namely, faculty at other law schools whose U.S. News vote they are trying to acquire.

Patterson predicts that similar changes will wash through law firm culture. She predicts that "lower salaries, fewer offers and a much more competitive job market" will encourage law students and law graduates to "focus on performance and achievement." She tells us that law firms "often condoned shockingly bad behavior by students during summer programs" and that this should end, explaining, "Firms now have a chance to teach tough lessons that will make better lawyers." Indeed, law schools ought to be taking advantage of the chance that briefly exists to "teach tough lessons that will make their students better lawyers."

Adam Cohen concluded with these words: "Law school deans, bar association leaders and firm managers should follow Rahm Emanuel’s advice about never allowing a crisis to go to waste and start planning for what comes next." Katharine Patterson ended her article with this advice: "We are all in this together, firms, companies, law schools, students, folks who want to make careers in the law. Let's take advantage of this time of change and invest in all our futures. Law practice has come a long, long way since 1980, and hard times give us the chance to build an even stronger future together." I conclude with this simple notion: Law school faculties are on notice that they can act now, when there is a chance to influence the transformation of legal education, or act later, when they are trying to survive the tide of change.